Wednesday, June 3, 2009

Are You SURE You Want A Mortgage?

Back on the interest rate spread and ratio front, this time on a pair of rates that involve retail banking customers, i.e. you and me: 30-year conventional mortgages (the banks' lending rate) and 1-month CDs (the banks' cost of borrowing funds). We can view this as indicative of gross profitability (gross interest margin) in retail mortgage banking, even though a growing proportion of mortgages are now ARMs (adjustable rate).

As the chart below shows, the spread is back near its all time high, but nothing truly out of the ordinary is happening. Banks are simply making a decent profit on these loans - though they are not making a lot of loans, of course..

Data: FRB St.Louis

But what about the ratio of the two rates? I know many think a spread, is a spread, is a spread - but I hold otherwise. Near boundary conditions (zero nominal rates) ratios matter, too. And here things look extremely extraordinary: conventional mortgages are going for an eye-popping 16 times more than the cost of funds (see chart below). Now that's what I call a profit!

So what, you may ask? Why is this zooming ratio important? Because, if things stay as they are for an extended period of time, new borrowers - wage earners like Mr. and Mrs. Average Joe - have no hope whatsoever of servicing these loans, eventually. Their cost of borrowing is sixteen times greater than the raises they are likely to get at their job - assuming they get a raise or even hold on to their jobs.

Don't forget that the extra money to pay interest has to come from somewhere and for most people it comes from getting a raise at their job. Putting it another way, the incremental cost of borrowing money is sixteen times greater than the incremental benefit of being employed. Are you SURE you want to get a loan right now?

Of course, there is a reason why all this is happening: the expectation of deflation is holding short rates (and pay raises) way down, while the desire to recoup massive losses and control risk is keeping bank lending rates high.

Hmm.. maybe we should move back to imposing strict regulations on retail interest rates? Say... 2-3x cost of funds for mortgages and a bit higher for consumer loans? Just an idea...

P.S. Someone asked me how the Oh, Very Funny Index (tm) is doing now. As of last night, it is up 70.8% from March 2, 2009 so the index is at 170.8. See below for individual performance of its components.


  1. Nah. I would suggest strict regulations on central bank interest rates. Say never less than 2-3%. Even in deflationary circumstances.

  2. I feel like Joe on this one.
    The modern day witch speaks...
    Those theological debates way back there in the 14th century are sure looking pretty interesting on this one.
    The art of MAKING A KILLING on lending money.
    Since we are so collectively FIXATED on filthy lucre, we manage to multiply, divide, add, subtract (all abstract operations) the numbers until we're blue in the face, while the real economy sinks like the Titanic.
    A little bit like fiddling while Rome burns.
    (But I guess that Nero didn't really do that, we just think he did...)
    We are far more interested in our symbols than what they are supposed to represent.
    We will PAY for this.
    And money will just not do the trick, will it ?

  3. The "basic" problem with interest rate policy is that we are all collectively stuck with the notion that "The Economy Must Grow", regardless of what it means to the environment, our children's future or quality of life.

  4. "...the notion that "The Economy Must Grow", regardless..."

    As long as our money is made up of debt, the economy MUST grow to service that debt. The only way to slow down without going broke is to have interest-free money issued as sovereign credit but that idea is what got JFK killed.

  5. Inflation will solve this problem. Isn't this the hope of the Geithner regime?

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  7. Maybe the bank should pay me more then 1% on my CD, I really should take out all my money and stuff it under the mattress. Screw this.

  8. Its the last minute grab by the rats before the ship goes down...

  9. Geez you guys, look at that comment, Deepika says, are we really going mainline, I mean I like confidentiality and quiet rooms where we can all smoke cigars after our meals and discuss in a civilized manner while the ship goes down...
    I don't know if it's elitism or CIVILIZATION...
    Yoyo's comment makes me reflect on why they called those things "junk" bonds.
    Not like "junk".
    More like "junky"...
    Like, where's our next collective FIX going to come from ?

  10. "The Economy Must Grow"

    If the economy does not grow, then the established monied class (wall street and Washington) would lose power quickly and control of congress would revert back to Americans.

    We do not want that.

  11. Over here in the UK the 25yr mortgage rate will be around 5.8%. Most people here in the UK will take out a 2-3yr fix (2.99% with a 30% deposit) or a 5yr fix (4.48% with a 30% deposit). How much QE has played in these rates I don't know. Popular opinion about property HASN'T changed much despite indices down 17% from peak, property programs still pollute the TV channels, and our Chancellor (Sec to the Treasury) has been found out using taxpayers monies to flip property. Hell, when do you feel the Bond markets will force Gilt yields?

  12. Yes - I would!

    With every gubmint in the world printing money and running deficits as fast as they possibly can a deluge of bonds is going to hit the market. Demand is going to be swamped, prices will fall, long bonds@low, fixed, coupon will fall the most, hence we wan to be short those bonds as much as possible!

    So, I am planning to use the "eye of the hurricane" - while the interventions "work" - to swap my 4%, 30 year mortage for an even larger 5%, 30 year one - I believe the bonds will have halved it's value before 2015, where I will swap it for a low interest 1-year mortgage, buy back the 5%, 30 year bonds in the market and pocket the diff.

    This is Tax Free too - in Denmark, don't try this at home ;-)

  13. "As long as our money is made up of debt, the economy MUST grow to service that debt. The only way to slow down without going broke is to have interest-free money issued as sovereign credit but that idea is what got JFK killed."

    Thats right, and that's why Obama will rather kill the US economy, being the puppet that he is.

  14. fajensen- fascinating idea!

    Still I keep wondering if we are just witnessing a large dollar carry trades.

    Such a possibility would (I think) explain much of what Hell has been saying AND much of what we are seeing in the markets right now. Just looking at Hell's Very Funny Index reminds me that nothing makes any sense UNLESS there is something like a dollar carry trade (and it would be easy to set one up as US short term rates are very very cheap vs. other countries).

    All those housewives in Japan did it for their currency, maybe they are doing it to our?

    If we are in one, and it reverses, you would get a wicked crushing on your home refinancing.

    So as honest friendly advice from one resident blogger to another, you might just check to see if there is any way of disproving this theory as it keeps rattling around in the back of my head.

    Again, it may be the silliest idea I have ever had, I am the first to admit that I don't really understand currencies very well.

    Indeed, I would be awfully nice if Hell would help his readers to understand these kinds of currency issues better (I know he does not give investment advice).

    Anyway, good luck

  15. Hell: "The "basic" problem with interest rate policy is that we are all collectively stuck with the notion that "The Economy Must Grow"...

    Is it growth or the Government must inflate to reduce debt? What did Rothschild say again?

  16. Re: Dollar Carry Trade (Thai's comment)

    Actually, this has been going on in my mind as well for quite some time. With dollar interest rates so low it would make theoretical sense.

    But the problem is, what to buy with the dollars? A carry trade means the dollars are converted into another, higher-yielding currency. And there aren't that many of those around, at least not in any size.

    So, I think what is happening is the outright purchase of tangible items priced in dollars. For example, the Chinese buying commodities and ships, instead of Treasurys and US mortgages.


  17. Well, I don't mean to sound TRIUMPHANT or anything, LOL, but, the idea of using that useless filthy lucre to buy TANGIBLE items while it was/is STILL worth SOMETHING had crossed my mind too.
    And since I have no illusions about having EXCEPTIONAL intelligence, that means that it crossed the mind of millions of other people too...

  18. I am glad you brought attention to the mortgage debt of consumers. Many economists want to only concentrate on credit card debt. However, because of the recent housing crisis, mortgage debt didn't seem like such an asset. This caused the full $14 trillion of consumer debt to become apparently large. Hopefully, we can reduce more consumer debt together.

  19. I still love your blog and still read it religiously, (but maybe not every day!)

    The relationship between the banks cost of borrowing and the mortgage rate are completely irrelevant. A buyer of a house should not be, and historically was not, dependent on raises to service his/her debt. In fact, that is one of the things that has made the us housing market so stable for the last 70 years (with the huge notable exception of the last 10 years of home atm nonsense)

    If you borrow for 30 years, fixed, based on current income criteria, then you should have a reasonable expectation of being able to pay at least that for the next 30 years. Your income doesn't have to go up, because your payment is not going up.

    Yes, s**t happens, and sometimes your income goes down, but that has no relationship to the bank's cost of borrowing.

    So, I bought a house 27 years ago at 7%, and have 3 years left to pay. My income has been wildly higher than it was when i bought the house, and now it is about the same (without any adjustment for inflation) as when i bought the house, and the payments are the same. (The property taxes are a whole 'nother story.)

    A built in feature of the 30 year fixed mortgage is that over the years, your income is likely to go up, making the payment less and less of a burden, but if it is originated properly, it is not a necessary condition.

    Since the fact that you're brilliant is a given, i sure would appreciate it if you would explain to me what i'm missing.


  20. Define fascism smart guy?

    Hatred of communism
    Hatred of liberals
    Hatred of "itellectuals"
    Hatred of homesexuals
    Hatred of unions
    Belief in Corporatism
    Belief in Military might
    Belief in Military pre-emption
    Obsessive Nationlism and Patriotism
    Belief in "US" vs. "Them"
    Belief in "We are better then them"
    Radical religious ideologies (taking a religion and warping it into a nationalistic & militant construct)
    Belief Social Darwinism
    Use of Media Propganda and Scare Tactics to indoctrinate population to fascist beliefs


    Holly Crap - The Republican Party are FASCISTS.

    Except for Ron Paul - only conservative

  21. China is going to help the world out of recession?

    Google Chinese Drywall. LOL

    A friend of my imported building materials from China and they were stopped by customs because the metal was radioactive! LOL.

    The goods news is that after about 20yrs there should be lots of dead Chinese.

    The only long-term growth industry in China will be cancer drugs and treatments.

    Hope the Chinese idiots do not cause Black Bears to go extinct due to fold remedy demand.

  22. Are you SURE you want a mortgage?

    Great title. This funny bit should have been given that title: